Financial ratios are used to evaluate the business. There are a number of ratios that are commonly used by bankers, by vendors extending you credit and by lessors. Here are some of the more commonly used ratios and what information they provide. If you are familiar with these terms, you will be able to monitor how your business is viewed by an outside party.

Liquidity
This is a measure of the business’ ability to pay its short term obligations.

Current ratio = Current assets / current liabilities
Quick ratio = Current assets less inventory / current liabilities

Activity
This is a measure of the business’ efficiency in generating sales with its assets.

Inventory turnover = cost of goods sold / average inventory
Fixed asset turnover = sales / net fixed assets
Total asset turnover = sales / total assets

Leverage
his is a measure of the business’ degree of indebtedness and its ability to meet its long term obligations.

Debt ratio = total liabilities / total assets
Debt to equity ratio = long term debt / equity

Profitability
This is a measure of the returns on assets and equity or how efficiently your investment is earning income.

Gross profit margin = gross profit / sales
Net profit margin = net income / sales
Return on Equity (ROE) = net income / equity

There are many other ratios that are used in evaluating the specific financial performance of a company, but these are the most common. If you are familiar with these and monitor them from time to time you can better determine if your business’ financial condition is improving.
 

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